(N.B. Before reading further please note that if your scenario is one where you are looking for equity investment then investors will be subscribing for new shares issued by the company and the post below will largely be irrelevant. Instead you should read ‘how to allot and issue new shares in a UK limited company‘.)
This post provides an overview of the applicable law and procedure when transferring shares in a private limited company incorporated in England and Wales, where the transfer involves a voluntary conveyance of the legal and beneficial interest in shares from one person to another. I have not covered a transfer involving a buyback of shares by the company, although it is common for at least some shares to be bought back by the company in management buyout scenarios when existing shareholders are buying out other shareholders and staying on to run the company.
In the company’s articles of association or its shareholders agreement (if there is one) then there will usually be pre-agreed procedures set out that are required to be followed for any transfer of shares in the company. The main procedure usually gives existing shareholders a right of first refusal (to buy the shares at the same valuation as has already been offered for the shares) which will lapse after a few days before the shares can then be transferred to any party outside the group of existing shareholders. If any restriction is contained in the company’s articles, the shareholders could resolve to amend the articles to remove or disapply the relevant restriction, either generally or in relation to the proposed transfer only. Unless otherwise varied, amending the articles requires a vote of 75% of the voting shares, whereas shareholders agreements can only be changed unanimously.
If a company has a shareholders agreement there is usually a mechanism agreed on for calculating the valuation of shares in particular circumstances when shares are to be bought back by the company or offered to other shareholders, as well as details of who will carry out the valuation.
Otherwise, there are lots of ways to value a private company, but at the end of the day the price will be what it is worth to the buyer to acquire the shares, which can be influenced by many different factors. For example, value may be set by the company’s asset value, or have more reference to its revenues. Sellers can help increase the value by agreeing not to compete with the company in the future and hence give an added restriction benefit to the buyer. If you are only selling a small proportion of the company’s share capital, then there will usually be a minority interest discount as by having such a small interest in a private company shareholders will struggle to influence the running and direction of a company.
For transfer procedures in a company’s constitution, companies will usually turn to their accountant when seeking a valuation, but often it will be difficult for them to be truly independent, especially if their relationship with one or more shareholders is more important than with the others. It may therefore be better to turn to a valuer unknown to any of the parties. In such circumstances I often refer a company to a specialist and affordable accountant who is experienced in carrying out valuations of private company shares and can help limit the potential for friction and disagreement between the shareholders (if for example there is a management buyout type of scenario when shares are being acquired by other existing shareholders).
A share sale is typically more complicated than when just assets are being sold, since with shares you are selling not only the assets, but all the liabilities of the company too. The buyer will, therefore, often carry out a detailed investigation or ‘due diligence’ exercise before buying the company’s shares.
Once heads of terms have been agreed, the buyer or his solicitor will send the seller a detailed due diligence questionnaire asking for certain documents and also containing several questions for the seller to answer. The responses to the questionnaire will help the buyer know if they need to re-negotiate the price they are paying for the company’s shares and also give them an idea of what type of contractual protections and provisions they will need in the share purchase agreement.
Buyers will usually require extensive warranties and indemnities from the selling shareholders in the share purchase agreement. The warranties also serve as a way of enabling the buyer to acquire more information about the target company as the warranties (given to reflect the status of the company at the time of completion), to the extent they are untrue, require the sellers to disclose all material facts qualifying the warranties in a disclosure letter (see below) so that as a result of doing this the buyer can’t have any action against the sellers for a possible breach of warranty.
Due diligence may also be carried out through a data room when companies are sold by auction.
Share Purchase Agreement
The main document that governs any significant sale of shares in a private company is commonly known as a share purchase agreement or SPA, although the terms “share sale agreement” and “sale and purchase agreement” are also used interchangeably.
There is no legal requirement for an agreement for the sale of the legal and beneficial title to shares to be made in writing and for small transactions a buyer may be happy to exchange just on the basis of a signed stock transfer form and resolution authorising the sale. Where the buyer has little knowledge of the company, there are several associated risks (including post-transfer obligations such as deferred payment arrangements), or the consideration being paid is relatively sizeable, then a buyer will almost always insist that a detailed written share purchase agreement is entered into between the parties. It is therefore usual practice for the buyer’s solicitors to produce the first draft of the share purchase agreement.
The terms and complexity of a written agreement for the sale of shares will vary depending on the nature and circumstances of the transaction, but it will typically be a lengthy document, half of which (or sometimes more) can be devoted to a schedule of warranties. Other common contractual protections included in the SPA will be non-compete undertakings from the sellers and earn out arrangements (where all or part of the purchase price is to be determined by reference to the future performance of the target company).
Exchange and completion in respect of the SPA normally takes place simultaneously, although there is sometimes a gap between the two if, for instance, a tax clearance or a shareholder consent is required. An example of when tax clearance is required would be if the seller is taking some form of paper consideration (such as shares in the buyer or loan notes) in return for its shares. The seller may request clearance from HM Revenue & Customs under section 138 of the Taxation of Chargeable Gains Act 1992 in connection with rolling over into paper the gain that would otherwise be realised on the sale of the shares.
In an auction sale the SPA is normally drafted by the seller’s solicitors because it will be the seller attempting to control the process. With an auction sale the sellers will also put together a data room (which is now usually provided online), or a disclosure package prepared against a common set of warranties. Prospective buyers are then asked to make their offer based on the pre-prepared contractual documentation provided, although these documents may then be negotiated further with a potential buyer.
As mentioned above, a disclosure letter is produced by the seller in relation to all the warranties detailed in the SPA. For a disclosure to qualify a warranty, such disclosure must be full, clear and accurate. It must identify the nature and scope of the matter disclosed and be clear enough to enable the buyer to have a complete understanding of the issue.
Stock Transfer Form
A stock transfer form is a two page document that is filled in by the seller with such details as the name of company, name of transferor, name of transferee, number of shares and price per share. The name and address of the person or people receiving the shares also needs to be included, although they will not normally need to sign the stock transfer form.
If the value of the transfer is more than £1,000 then the buyer has to pay stamp duty on the form at 0.5% of the total amount rounded up to the nearest whole £5. The original signed form and a cheque is then sent to the relevant HMRC stamp office who then return the form to the buyer once it has been stamped. The deadline for paying the stamp duty due is 30 days after the share transaction takes place.
This post includes an informative guide on how to properly complete a stock transfer form.
Other Procedural Formalities
Once a transfer of shares has been approved and the parties have signed the SPA, the company must take the following procedural steps:
1) Update its register of members to reflect the transfer.
2) Cancel the seller’s share certificate and issue a new share certificate to the transferee.
At the same time as the SPA is entered into new directors are also appointed before any selling directors then resign. Appointment and termination forms are filed at Companies House, while a departing director will also often sign a resignation letter confirming that they waive any possible future claims they may have against the company.
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